Separating Narrative from Structure: The 2020 USD Bear Market

Following the significant fiscal and monetary stimulus at the onset of the pandemic in 2020, there was a growing consensus for the end of US exceptionalism and the beginning of a multi-year decline in the USD.

We viewed the DXY decline differently – as the final leg of a larger corrective structure that would ultimately set the conditions for a bullish reversal.

The foundation for our DXY view goes back to our Update on 23 March 2020.

Our long-term framework suggested the DXY could be developing within a larger corrective structure leading into the pandemic. However, as of March 2020, that structure remained incomplete.

The near-term outlook implied two possible resolutions, pivoting around a clear inflection point at 104 (pink resistance line below):

Resistance is resistance until broken and the wave count is binary here. Bullish green count on a strong close above 104 likely sees a wave 3 extension higher. The red bear count sees an impulsive rejection of major swing highs. (Source: Mars Market Update – Preservation of Capital, 23 March 2020)

Technical analysis overlay for the DXY showing the 104 inflection zone and potential impulsive (green) and corrective (red) scenarios, 23 March 2020.

The rejection from the 104 resistance zone in March 2020 shifted the balance of probabilities toward a final downside leg (red wave marked (C)) to complete the broader corrective structure.

If this “corrective path” was accurate, we’d need to see this wave (C) price action confirm with an impulsive decline to complete the bigger picture correction around the 87.70 area target.

Interpreting the decline as part of an ending, corrective structure had important implications for our broader Dollar outlook. It allowed us to adopt a near-term bearish stance in 2020 while maintaining the expectation that completion of the final wave would set up the conditions for a bullish reversal.

Following the rejection from the 104 resistance zone, the DXY began the final downside leg, setting up our near-term bearish outlook.

As the DXY declined through 2020, the gap between the prevailing bearish narrative and our market structure analysis widened.

The consensus view treated the decline as validation of a structural bear market and the narrative around the Dollar outlook became increasingly bearish. By the end of 2020, bearish positioning in the DXY reached extremes, with the CFTC non-commercial net short position as a share of open interest at a post-GFC low as of 21 Dec 2020.

At the start of 2021, the corrective “(A)-(B)-(C)” structure appeared to be nearing completion. The final red (C) wave lower had developed impulsively through 2020 and was approaching minimum downside targets.

The DXY has declined impulsively from its March 2020 wave (B) highs. Our base case is that this decline is in the final waves of an a-b-c correction with the DXY turning bullish early in the new year.

While minimum targets have been met for an impulsive 5 wave decline, our measured targets for wave (C) remain lower towards 87.50 where (A)=(C) and a 50% retracement from the January 2017 highs. We are now looking for evidence of a bullish reversal in the DXY to establish longs as we approach this inflection point. (Source: Mars Market Update – Year Ahead: Super-cycle High, 4 January 2021)

Technical analysis overlay showing the DXY completing the broader corrective structure and approaching the bullish inflection zone, 4 January 2021

By interpreting the 2020 decline as part of a larger corrective structure rather than the beginning of a secular bear market, our framework provided the structural signals needed to prepare for a bullish reversal as the decline matured.

The DXY subsequently established its cyclical low at 89.209 before rallying through to a high of 114.78 on the 28 September 2022.

Importantly, the framework helped prevent us from becoming anchored to the prevailing secular bear-market narrative as bearish sentiment reached extremes.

Technical analysis overlay showing the DXY approaching upside targets during the rally into September 2022, 26 September 2022.

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